SAVE without Spirit: Priceline’s Compromise Engine

Depending on who you are, the most important factor in making your travel decisions is going to be one of the following: service, convenience, comfort, price, incentive, or some offshoot of one of these. For flights, most people probably agree that price is what matters most since in most situations it’s safe to say people aren’t going to be comfortable on an airplane no matter what.

But for hotels, things are a lot different. You have your 1%’ers, who don’t mind paying the extra $100-200 per night for the Four Seasons or another luxury hotel because their focus in on comfort and amenities. You’ve also got your… let’s call them 47%’ers, who don’t mind the accommodations and simply want the cheapest price around. And then you’ve got everyone else. Price matters, but enjoying a vacation or whatever it may be also matters, so price isn’t everything… but it’s a big thing, and still the main thing. These people are in luck.

Through their “Name Your Own Price” booking engine, Priceline.com (PCLN) has staked its claim as the TJX of travel retailers.

Now before you run out and buy the stock because it was mentioned in the same breath as TJX, let’s walk through how it works. As some of you probably know from experience, Priceline offers what they refer to as an “opaque” retail transaction, meaning the main details of the hotel, flight, or whatever accommodation it may be are given to the customer (e.g. price, proximity to desired location, room size/beds, specified amenities, etc.) but not all the details, including which travel supplier is behind the offer. In exchange for sacrificing some specifics, customers can get a discounted price for these accommodations. Customers simply provide the price they are willing to pay for their desired accommodations and Priceline will search through its inventory of discounted offers received by travel suppliers for any that hit that price point, or are closest to it. Once the customer sees the basics of the travel items being offered, if they choose to accept it they are then given all the details and the deal is finalized – no refunds or cancellations. Think of it as a blind date service for price-conscious travelers and desperate travel suppliers.

The bulk of the Name Your Own Price sales are hotels, so we will focus on that for now. Priceline is essentially a hotel’s surplus store, which they can fall back on if they end up “buying” too much inventory / not selling enough. Of course, Priceline is able to scoop these up at a discount, so the value-add slides down the supply chain and everybody’s happier thanks to the innovative feature, right?

I’d love to know what makes the opaque selling model such a Priceline-centric thing and why Expedia can’t do it, or why hotels don’t just throw these accommodations out into the GDS world for all travel agents to see after a certain amount of time. The obvious answer is that if customers know they can get a discount by waiting until the last minute or if they know others are paying less for the same accommodation, hotels will have all their price points pushed down as a result. But finding some way to justify their discounted nature couldn’t be too hard, could it? Loyalty programs? Anything?

If we know anything about Priceline, it’s that they’ve had one hell of a run in the 2000s, perhaps being the premiere growth stock outside of maybe Apple and Google. From as low as a pre-split $7 share price to a high of around $700, the stock has rocketed upwards and currently trades at about 25-27x TTM earnings. For a growth stock like PCLN, it’s probably fair to look for a multiple somewhere in line with their growth rate, which I’ll define simply as earnings per share growth year-over-year. Right now, 5.25B in revenue and analysts see 6.3B for 2013, which works out to [literally] 20.00%. Seems like analysts really like round numbers, or perhaps they’re a bit lazy. I’m sure it couldn’t possibly be the latter, however. Analysts also look for similar EPS growth for 2013, with forward earnings of $37.43 and 2012 looking to come in at $30.91. For reference, 2011 was $23.45, which is just over 30% growth, so that would be a slight slowdown being forecast by analysts. Nevertheless, at that growth it’s easy to see Priceline look attractive at 20x and possibly even its current 26x if the company’s long-term profile looks promising enough.

At the moment, like Workday I’m not confident I know the answer to this one, but if it’s fair to draw some parallels between Priceline’s model for travel suppliers and TJX’s with apparel retailers, the economic viability of the model has been proven over the long-haul and Priceline might have the advantage of accelerating air traffic to grow at 20% for the foreseeable future. Will continue to update this one as I see more. Again, the only thing I really do know is that I continue to love Amadeus for its ability to be the epic middleman it’s shaped up to be. Might have to revisit adding to that position before earnings.

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Comments (4)

Alright, the opaque business is actually not the growth story at PCLN - domestic bookings, which are largely the opaque business, have been growing in single digits lately. Others *do* have opaque businesses - for instance Hotwire, which is owned by Expedia. The growth story at PCLN is "international bookings" - namely, Booking.com and Agoda, as well as rentalcars.com (formerly traveljigsaw).

Booking.com is *the* dominant European online travel agency (OTA) - though EXPE does want to enhance their position there with recent initiatives (their recent tech re-platforming effort that has just completed as well as Expedia Traveler Preference [ETP], that enables pay when you check out [agency model] vs. their merchant model [pay the OTA when you book]). The European markets need OTAs more than the US because the supply base is more fragmented - more independent bed & breakfasts vs. chains in the US. Combine this with a simple but powerful tech platform and a maniacal focus on search engine marketing (GOOG Paid Search), and B.com is dominant in Europe. Further, because they have an agency model, their take rates are lower than Expedia (go do your own research to figure out by how much), so hotels like them better.

Where it gets really exciting for PCLN is Asia, Latin America...and the US. With their pending acquisition of KAYAK, PCLN is going to get a much bigger presence here in the US. While Kayak will likely run as an indepent business within PCLN (much like TripAdvisor did as part of Expedia before the spin), Booking.com has also just started a TV campaign - Booking.yeah, to increase awareness among US consumers. With regard to APAC and LatAm, just huge secular growth ahead for all the OTAs, including PCLN.

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Thanks for the color. I've done a decent amount more work on PCLN since writing this primer and definitely seeing that the international bookings are where it's at in terms of growth. Looking at the business from a high level I saw the opaque services as a major differentiator so kinda clung to that before actually moving any further. I think the number was something like 88% of gross profit ended up coming from international hotel bookings in 2011 and for the most part the YOY growth for NYOP and domestic bookings merchant and agency are becoming less of the mix (hence the higher gross profit margin). Given what I've seen from the travel industry in general it definitely makes sense that the whole APAC region in particular would be the growth engine as both destination and point of sale.

Things like Expedia Unpublished Rates, Room Key, and whatever else that basically compete with NYOP are also kinda scary so it's really all about international in terms of things I'd feel confident they can grow. Kayak should help in the US but again, I think that's the last place you want to be putting all your eggs if you're a travel company just because of the consolidation in airlines, hotels, and other travel suppliers, plus they have so much pressure to cut costs and investors with higher demands for return on capital to go along with it. That's not really the case in Eastern Europe, Middle East, APAC, etc. So the international focus is everything, and Booking.com and Agoda are well positioned to keep it going.

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Thanks for the color. I've done a decent amount more work on PCLN since writing this primer and definitely seeing that the international bookings are where it's at in terms of growth. Looking at the business from a high level I saw the opaque services as a major differentiator so kinda clung to that before actually moving any further. I think the number was something like 88% of gross profit ended up coming from international hotel bookings in 2011 and for the most part the YOY growth for NYOP and domestic bookings merchant and agency are becoming less of the mix (hence the higher gross profit margin). Given what I've seen from the travel industry in general it definitely makes sense that the whole APAC region in particular would be the growth engine as both destination and point of sale.

Things like Expedia Unpublished Rates, Room Key, and whatever else that basically compete with NYOP are also kinda scary so it's really all about international in terms of things I'd feel confident they can grow. Kayak should help in the US but again, I think that's the last place you want to be putting all your eggs if you're a travel company just because of the consolidation in airlines, hotels, and other travel suppliers, plus they have so much pressure to cut costs and investors with higher demands for return on capital to go along with it. That's not really the case in Eastern Europe, Middle East, APAC, etc. So the international focus is everything, and Booking.com and Agoda are well positioned to keep it going.

Yup, largely agree - just a heads up, the agency revenue gets booked at 100% gross margin and the merchant business as gross revenue, so investors tend to look at margins on this business with gross profit as the denominator (i.e. EBITDA / gross profit).

I would agree with you that the US is not where you want to be concentrated given the concentrated supply, but for PCLN, the US market is largely greenfield (except for the NYOP piece), which is why Booking.yeah and Kayak are exciting - its all incremental for Priceline, their share to gain here vs. (largely) Expedia (as well as other OTAs, supplier websites and offline travel agents) to lose.

APAC in particular is interesting - EXPE is attacking the domestic China market with eLong while PCLN partnered with CTRP (the largest OTA in China) to provide outbound inventory while Agoda is slowly but surely building up a domestic business in China...

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